Wednesday, March 11, 2009

Redesigning our Economy, Part 1

In the early part of the last century, nations began to abandon the gold standard in favor of fiat money. The possibility to redeem money in specie was finally given its global death blow in 1971 when the United States terminated its obligations under the Bretton Woods Agreement. Today, the government in theory controls our money supply by pure fiat. But unfortunately it's not that simple since new value is also created out of thin air as private entities create and trade options and securities. The only portion of the supply that a central bank controls is how much so called printed money is in circulation (whether such printing is physical or by lowering requirements on electronically held banking reserves is irrelevant). However, even the supply through the generation of private securities is not beyond the control of the government since the private sector can be regulated through legislative acts combined with judicial enforcement. Ultimately, we are in the position to decide how our monetary influx is to be controlled in order to prevent extreme fluctuations in our economy.

Although the government should not due to organic principles be considered one and the same as We the People, the government aught not to be needlessly vilified and equated with totalitarianism as soon as it exerts any form of centralized control. I won't argue this point here in any great length since it deserves a well thought through post in its own right. Suffice to say that I would claim that a stable society, in fact any system per se, perfectly balances centralized and local control. A perfect government allows We the People to regulate the government through occasional intervention (such as elections), potentially overthrowing the established order without reverting to violent revolt.

The money supply, being one of the non-localized pillars of a stable society aught to be under maximized central control by the government. I will even go one step further, claiming that our money supply aught to be maintained by automatic so called homeostatic mechanisms. However, how money is borrowed and lent should remain a purely localized (i.e. private) matter. To be more accurate about my claims, it's not that the government's authority to use the money supply as a control mechanism should be enhanced. To the contrary, that authority should actually be removed from both the government and the private sector as much as possible. The only responsibility the government should have is to execute the homeostatic mechanism required to maintain a steady cost of money.

Some have naively advocated a return to the gold standard. Note that this in effect returns money supply into the private sector by making mining companies responsible for establishing a influx of specie (unless, of course, gold mining is nationalized). And even if this were to be considered acceptable, there just isn't enough gold to guarantee redemption as our global society expands and intensifies its activities. We need to peg money to something more fundamentally intrinsic than material goods: human labor, or to use a more modern term, services (since labor has become equated with physical rather than mental work).

The flaw of any specie-backed currency is that no specie has in-and-of-itself intrinsic value. On the surface it may seem as if some raw materials, such as gold, have lasting value. This is simply not true. All materials are only as valuable as that for which they are used. It's only by putting them into the context of a service that they are of any importance to us. Gold or iridium cannot be eaten or drunk. None of the elements of the periodic table are on their own sufficient to support biological functions. And a thing can only be said to approach an intrinsic value if it serves our most basic biological needs. Only a few abundant combinations of naturally occurring elements come close to sustaining life as such (e.g. water and air).

Gold only seems valuable in-and-of-itself because of its imperishable and non-toxic nature. Perhaps it also seems to have constant value due to a human propensity to being attracted to all things that glitter. But copper has been a specie to back currencies as well, so its less the superficial value of the bright color of gold than something else that caused it to have such importance to our money supply until 1971. It was the durability combined with the relative rarity and difficulty of extracting gold that caused it to be used as the predominant basis for money. Though it may seem ridiculous, imagine for a moment that water (which can be said to have some form of "intrinsic" long lasting value) were to be used as specie. That would mean anyone could introduce new money into our economy by simply draining a lake.

Gold and all other materials from oil to uranium are worthless to us unless we put them to good use. And all other useful materials, such as livestock and grain, are perishable which makes them particularly unsuitable for backing any currency. So what are we left with to back the value of our money? Nothing except humans. Humans may be perishable, but their brains, their capacity to store information and and their inherent will to apply themselves makes them invaluable to other humans. This may sound obvious, even silly. It can be argued that humans are sort of useless unless they know how to perform some particular service. And although it is true that a neurosurgeon is not born from the womb, almost all humans have the natural capacity to learn.

Recorded intellectual property is perhaps the only thing beyond our brains which is intrinsically valuable to us. It's only in the context of intellectual property that iridium, oil, coffee beans or horses are of any importance to us whatsoever. But again, intellectual property is less than useful without the knowledge and experience in how to apply it. All real value circles back to human labor per se. And even if a lawyer is paid more than an orange picker, there is a lowest common denominator that renders any sentient human useful. Hold this, do that, suction here. Not like that, like this. What a few instructions and just a little training almost any human (except those whose brains have been severely compromised) can be put to good use.

Therefore, all currency is ultimately backed only by human labor, regardless of whether it is redeemable in some given specie or not. Fiat money is simply a gradually heightened awareness that the only ones who can ultimately redeem money is those who can, under extreme circumstances, require human labor through obligatory civil and military services. The only institution that has and should have that authority is our government (i.e. that which governs us). Only a pure anarchist would claim that the government should have absolutely no capacity to control human labor (and it can be argued that a truly anarchist society cannot exist by virtue of the very meaning of society).

It is not wrong for the government to demand certain actions as long as it respects a set of fundamental human rights that are constitutionally enshrined. Without the authority to demand labor, government could not exist. There would be no ability to rapidly expand our military and civil structures when under a foreign threat. In the U.S. and some other countries there would be no juries of peers. There would be no judicial sentencing beyond forced imprisonment (i.e. no one could be required to redeem themselves through community services). Such authority should not be equated with slavery. Slavery is an abomination because it places the capacity to enforce labor in private hands and suspends our most basic civil rights.

Interestingly, a debt to the government is indirectly a transfer of its authority to demand labor to a private party. When you buy a treasury bond (or obligation as it is known outside the U.S.), the government ensures in good faith that it will redeem that bond at a future point of time (it is obligated to do so). The way the government ensures its ability to repay you is through taxation, by selling further bonds or printing more money. The latter two are of illusory means of paying back since the first is just a crazy Ponzi scheme and the latter is just creating empty value. Printing money causes the value of all the money currently in circulation to decrease, thereby artificially eliminating the government's debt. It is no more than defaulting on an obligation. If we are lucky, it's a temporary band-aid for the economy. In the worst case, it's the Weimar Republic and hyperinflation, followed by a collapse of government as such. As I just said, it is the same as an institution defaulting on its obligations. And seriously, who except marginal extremists wants the government go belly up?

Taxation is what is of real interest. What is taxation? Taxation is nothing more than the government making you work for its benefit. It's the mayor means by which the government can legitimately redeem its debts, with other words back its obligations through human labor. Even if unlike obligatory civil and military services the government does not enforce you to work, the government enforces you to share the fruits of your labor through taxation. Since no one can really stop working and survive without someone else picking up the slack (i.e. providing charity), the government is guaranteed an income. It may not be outright controlling your activities, but taxation guarantees that you are in part laboring for the government whether you want it or not. Which is probably why many of us feel all grumpy about it. Very few of us like to be forced to do anything.

Public debt requires the government to transfer the benefit of your labor to some specific private entity (or foreign government). It's not slavery per se since it does not enforce specific activities that can potentially violate human rights. But it's akin to slavery because it enforces us to be in the servitude of someone who lent us money without any recourse to defaulting. Many try to wave this to the side by claiming public debt is just a debt to ourselves. Incorrect. Public debt is a debt we have to a specific entity. Yes, we (through our elected officials) chose to acquire that debt. And if there was no obligation to honor a debt, who would lend anyone money? But under private lending circumstances, an entity has a mechanism by which it can nullify its debts. We the People have no such recourse. Let me remind you that debtors prison was eliminated a long time ago with good reason.

Public debt is transferred from one generation to the next. The conventional opinion is even that if a government is overthrown, its successor government inherits the debt of its predecessor. Something is clearly wrong. How does a generation escape the sins and profligacy of its parents? I've read crazy claims such as the one that most spending is for the benefit of the next generation anyway. I simply do not buy that argument. I believe most debt is created to adjust for our mistakes, not because we are so fantastically generous to our children. Otherwise all of our spending would be directed to education and never to rescuing distressed financial organizations. Yes, there is such a thing as raising money to improve infrastructure. But is it really for our children that we do this? When we as a society spend money on a bridge or a scientific project, we do it with the hope that it will benefit us and not some distant future generation. The benefit for our descendants is a happy byproduct. Unfortunately, continuously deferred public debt (issuing bonds to pay for matured bonds) not only enforces our yet to be conceived grandchildren and great-grandchildren to pay for the benefit of our smarts. They will also have to pay in a very direct way for our grievous mistakes.

Obviously we cannot introduce a means by which the government is allowed to renege on its obligations. That's not my point. The government is not an entity like any other entity. If the government has a legal commitment it must be obligated to live up to that commitment under all circumstances. My point is that the government aught not to have such obligations in the first place! Some of you are going to sarcastically snark at such a suggestion. A government without public debt? How will the government save us from the brink of an economic meltdown or social catastrophe without being able to run a deficit? Well, there aught not to be the potential for sudden economic meltdowns. And social catastrophes should not be handled by borrowing money from war profiters, but by obligating private entities to directly serve the good of their commonwealth and by paying higher taxes.

Well, hunky dory and pinky roses. Perhaps we don't live in a perfect world and economic meltdowns are inevitable. Just like famines were inevitable in most countries before modern agricultural practices. We are not at the end of history! To accept extreme fluctuations in the economy as a natural part of human society is defeatist. Yes, all systems sway from higher to lower activity. But they don't teeter at the edge of extinction every 50th year (unless, of course, they're a human society that thinks its reached the end of history). Regardless of whether or not you reject Ricardian equivalence, you must answer to what extent offsetting the costs for solving a current crisis to the next generation is acceptable.

Obviously, if the future of humanity as such is at stake, maximizing labor efforts at any cost, even to future generations, is in order. But even if you are the most ardent Keynesian, do you really believe that bonds represent so more powerful a tool than taxes that it always trumps taxation when we are under economic duress? If public deficits are acceptable, then at least they aught to be temporary measures to overcome a temporary hump, not as it is and has been in the U.S. since Andrew Jackson, a permanent fixture of our economic structures.

I suspect most believe in a happy medium between bonds and taxes. But in my opinion, long term bonds always smell of deceit specifically because the Ricardian equivalence does not entirely hold. Everyone's awareness is tremendously heightened when tax issues are under discussion. And the reality of taxation presents itself directly as we file our returns, pay our gas and buy our clothes. But how many are continuously tracking at what level securities are issued by the government and to whom? To support the legitimacy of bonds is like objecting to elections because people are to dumb to vote. We are so jaded by our national debt that despite some occasional ruckus in the bowls of our national debate, we have become impervious to it. Perhaps it is irrelevant, a giant Ponzi scheme that doesn't really affect anyone because no one is willing to call our governments bluff (our own self delusion, so to say).

Unfortunately, in our global economy equating national debt with a debt to ourselves is no longer even remotely accurate. We are no longer playing a Ponzi scheme with ourselves and our grandchildren. We are now a bunch of strangers fueling each others excesive expansion and consumption, hoping, praying that the other ones won't get cold feet. I'm not trying to argue that incuring debt is fundamentally wrong. People and businesses need to be able to borrow money to further their (and thereby society's) progress. What I am arguing is that it's wrong for governments to incure debt when their is a more direct and transparent way for them to raise money for communal needs such as education, public transportation, law enforcement and basic health care. The government is the only entity in society that can legitamtely levy cumpolsory taxes. It does not need to borrow money if it has none.

Here it's certainly necessary to distinguish nations with emerging economies from nations with well established economies that are politically integrated into higher structures. The State of New York can receive adequate tax funds from both its own population as well as the entire tax base of the U.S. Federal Government. Burundi, on the other hand, is hard pressed to lift itself out of its own poverty. It depends on external funds for its progress. Creating incentives for such investments is important. I'm more focused on countries like the U.S.. But that said, I believe that even in the case of Burundi, intergovernmental lending and borrowing may not be the answer. Such lending does not seem to have had a great track record for equalizing the wealth discrepancy between nations. The answer I suspect is in local micro-funding at the private level, thereby generating a healthy private sector that the government can levy its taxes against.

The argument for issuing bonds often focuses on the effectiveness of offsetting costs to a time when a project is completed and capable of generating a benefit (or revenue) for its constituency. Seen from this perspective, even a transfer of cost to another generation can seem legitimate. Why should I have to pay now for something I will not immediately benefit from? The problem with such intergenerational arguments is that it assumes our capability to know what will be of any benefit. Every project is associated with a risk which burden only those who decide to be involved with the project should carry. When we engage intergenerational projects, who should shoulder the risk? Those who decide to engage in the project or those who those who engage in the project believe will benefit from it?

Imagine if I took out a loan to send my two young sons to an extremely expensive elementary school and put the loan in their name. I keep paying only the interest on the loan until they graduate from high school. At that point the full principle becomes due. But since its in my boys name, I wash my hands and leave it up to them. Okay, maybe I'm a little more generous and I extend the maturity to a point when I think they might be able to pay for it, say age 30. Would that be fair? They are, after all, the primary beneficiaries of their elementary school education. The glaringly obvious problem, of course, is that they did not have the capacity to consent! I chose their elementary school based on my belief of what their future aught to entail.

To me, this metaphor clearly illustrates that issuing any government bonds with a maturity beyond 15 years is unacceptable. I say 15 because that seems to be the rate at which culture switches from one generational view to the other. And 15 years is the average age it takes for a person reach maturity (even if you're really not truely matured untill you hit 50). One could argue that the longest maturity should be half of a lifespan. which (ignoring population growth) is roughly when those when those who could consent start becoming the minority. At some point I will hopefully have a little more time available to mathematically model what the maximum acceptable length of time for a bond to mature aught to be.

The problem is that the ability to issue bonds always creates the temptation to defer the debt by issuing yet another bond to pay for bonds that are about to mature. I'm leaning towards finding bonds an all together unacceptable means to raise government funds. If bonds are to be issued at all, they should always be issued only with a direct consent from a strong majority of the entire electorate (through referendums). And at their date of maturity, the should definitively be paid back through additional taxation specifically marked as a repayment for that specific public debt. This would  make the whole electorate fully aware about their previous profligacies (and thereby to some extent establish Ricardian equivalence) without the need for a complete economic meltdown.


SLP CHD said...

I am rather new to this blog-artform, having posted my very first just yesterday. Today, Google randomly chose to highlight your blog on my site, so I gave it a read.

You sound, though a bit wordy my friend, like a reasonably well-educated individual. Perhaps you would like to give my posts a reading? We come close to sharing an opinion on the matters of money and government, I think, and a penchant for mathematics. It might bear some future discussion.

sdorand said...

Global reboot. As much as I've tried to analyze the nature of the world's systems in their full capacity, the more it leads to madness.

All nations unanimously agree to cancel all debts across the board at the same time. The system of the world seems absurd. Drive from point A to point B. Move resource from point A to point B, etc. What is the higher purpose to it all?

I feel that all of the systems border on slavery and mind control. All land seems to be owned. Why is it that a man or group of people who deem themselves free can't seemingly exist in a community that does not take part in the madness but is able to grow their own food and electricity? Add to that the concept of a truly free and self maintained network and it seems to me that the need for an economy, giant industries, etc wouldn't really need to exist.

Why can there not be a handful of people from poor countries who seek out ways to do this for themselves? I think it's due to lack of will and government influence. If I found myself in the wilderness of the world, I think that over a bit of time I would have sustenance and quality shelter without all of the madness, malfeasance, and greed.

We exist to support the system instead of the system supporting our existence. It is upside down.

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